Statistics
There are several problems with how income inequality is treated. First of all many measurements use pre-tax income to measure this inequality. This is obviously extremely misleading to say the least, and when consumption inequality is measured, it becomes apparent that the poor are really not doing as bad as income inequality would have us believe.
How were the correlations between health problems and income inequality achieved? By looking at different countries. Looking at the same country during different time periods leads to completely different conclusions[2].
Talk
I would also like to point out some of common language used in the discussion over income inequality. Normally we are told that the share of wealth owned/earned by the lowest 20% has shrunk. This creates the illusion of the poor getting poorer and the rich getting richer, while most of the time this isn't the case at all.
I also find the talk about correlation infuriating. Causation is clearly implied, but they can't say it because there is no real theory behind it(or if there is, it's rare).
Another annoying term is income distribution. Distribution creates the image of a fixed amount of wealth that's then handed out to members of society, when obviously that doesn't represent the market economy in the slightest. A market economy is a series of voluntary exchanges and the amount of wealth is certainly not fixed. Someone earning more money does not mean someone else has to earn less. In fact if earning more represents greater productivity, then it necessarily benefits others.
Theory
As economists we must resist the temptation to make interpersonal utility comparisons. And that's what most of the discussion boils down to. E.g. applying the concept of marginal utility to money and assuming identical value scales among people makes it very easy to make the case for income equality(and maximum "total utility"). After all, what's one euro to a millionaire?
Ironically by using some (incorrect) armchair logic we can argue that precisely the rich value money much more than others, otherwise they wouldn't have gone to great lenghts to acquire and preserve all that wealth. Here I'm refuting a fallacy with a fallacy, since in reality we can't know people's value scales unless they are acting on them.
Do any of the problems that correlate with income inequality go away or get better if the state confiscates almost all of the wealth of the richest 1% and burns it to the ground? After all if income inequality is the cause, then that should help.
Someone might protest and say that I've got it all wrong. The argument is actually as follows: Taking from the rich and giving to the poor gives the poor better access to (e.g.) healthcare and education, and that's how their situation is ameliorated(and the rich are still rich enough to have good healthcare and education). Ok fair enough, but we're no longer talking about income inequality; we're talking about poverty. I recognize that poverty causes many problems, but poverty is not caused by income inequality(talking about real poverty, not "the lowest 20%").
And hey, what do you know? Poorer countries usually have greater inequalities than rich countries. No strawberry milkshake, Sherlock! That might have something to do with the correlations under discussion. The first applicable scenario that comes to mind is high inflation. Not only does that wreck the economy and make people poorer, it also wipes the middle class out(one of the classic symptoms of an inflationary policy is high income inequality).
Causes
After 15 seconds of Zen-like thinking I've come up with a complex theoretical framework that explains in detail why there is economic inequality. My answer: Some are just better at earning or stealing money. Not only are they better, but the best of the best are way better at it. Grab some online game that tracks how much and well people play it. Compare the differences between the best 100 players, then look at 100 mediocre players and you will understand what I'm talking about. You can look at sports, music or pretty much anything and the same pattern appears. The skill curve is "exponential" if you will.
No different with making money. Income equality has never been achieved on a large scale and schemes sold with it as a promise have ended up rewarding those who can navigate the political process(stealing). In a free society those rewarded know how to navigate the market process(earning) and in a mixed economy reward goes to those who can navigate both.
Consequences
I admit right now that income inequality might indeed have some negative consequences that make sense. However it must be remembered that even if these theories are correct, they must face the fact of opportunity costs(is it worth fighting this "problem?"). Measuring the costs and benefits of greater equality will always hit the wall of interpersonal utility comparison. Econometricians threw that principle out the window a long time ago, so they've obviously done some studies on this. Even so, it doesn't seem to me like the negatives are understood that well(not that I'd expect an econometrician to understand economics).
Income inequality does have one dangerous consequence that I'm aware of. It apparently causes people to lose their minds and come up with some pretty frikin' stupid ideas.
So here's the deal; income inequality allegedly causes depressions. I first stumbled on this idea in a speech given by Thomas E. Woods[3]. Two mainstream historians(David L. Wilson & Eugene P. Trani) wrote a book on the presidency of Warren G. Harding[4] and told us the following:
The tax cuts [after WWI], along with the emphasis on repayment of the national debt and reduced federal expenditures, combined to favor the rich. Many economists came to agree that one of the chief causes of the Great Depression of 1929 was the unequal distribution of wealth, which appeared to accelerate during the 1920s, and which was a result of the return to normalcy. Five percent of the population had more than 33 percent of the nation's wealth by 1929. This group failed to use its wealth responsibly.… Instead, they fueled unhealthy speculation on the stock market as well as uneven economic growth.Woods' answer:
If this absurd attempt at a theory were correct, the world would be in a constant state of depression. There was nothing at all unusual about the pattern of American wealth in the 1920s. Far greater disparities have existed in countless times and places without any resulting disruption.
In fact, the Great Depression actually came in the midst of a dramatic upward trend in the share of national income devoted to wages and salaries in the United States — and a downward trend in the share going to interest, dividends, and entrepreneurial income.
Stupid ideas never die, so now you can find quite a few articles on how income inequality caused the Great Recession. More importantly someone I know very well(someone who IMO should know better) told me she believes in this theory. As I can't articulate my ideas well without writing them down, I simply said I disagreed with her. Now I write. As Woods already pointed out, historically the theory makes no sense.
The rich save and invest more. So if more goes to them and not the wages of normal people who'll just consume most of their income, it'll create a speculative bubble. I guess the rich have now "too much" to invest and so they take more and more risk. I'd like to point out that one main reason for the demand for higher yields was the fact that central banks kept interest rates too low. Safe investments didn't pay.
This theory resembles the "savings glut from China" argument that we heard so often in 2008(I haven't seen that argument in a while... maybe it actually went away?). Globally the savings rate was actually lower than in the previous decade, so empirically it makes no sense. And why was the bubble biggest in the US? After all, their savings rate went negative, so they should've had the smallest bubble of them all. In China it should be the opposite.
The short answer is that more saving and investment simply creates... more investment projects. Nowhere in this "theory" is the "cluster of errors"[5] made by entrepreneurs explained. To be fair, if no one saved and invested anything, then we indeed wouldn't have business cycles. We wouldn't have anything for that matter, since we'd be living in the stone age.
Equality
"Equal" is a mathematical term that is used when two things are exactly the same. People are not the same, they are all different. It is a blessing that this is so, or social cooperation and the division of labor wouldn't be nearly as beneficial as it is now. A world of income equality isn't real, it is an absurdity that denies the existence of differences between people. One might as well try to create a world without geniuses and dullards.
I do not say that income inequality is "good" or "bad". The only "equality" I believe in is the one before law.
[1] Tuloerot repesivät yhtä isoiksi kuin 40 vuotta sitten
[2] Look at the changes, not at the levels
[3] Why You've Never Heard of the Great Depression of 1920
[4] Presidency of Warren G. Harding
[5] The Positive Theory of the Cycle
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